May 4, 2009
The Gibson, Dunn & Crutcher Financial Markets Crisis Group is closely tracking government responses to the turmoil that has catalyzed a dramatic and rapid reshaping of our capital and credit markets.
We are providing updates on key regulatory and legislative issues, as well as information on legal and oversight issues that we believe could prove useful as firms and other entities navigate these challenging times.
This update focuses on the latest quarterly report from the Office of the Special Inspector General for the Troubled Assets Relief Program ("SIGTARP"). The report, issued on April 21, 2009, provides Congress with an update on the TARP programs, describes SIGTARP’s oversight, investigations, and audit activity, and issues recommendations regarding the operation of TARP. SIGTARP was created under Section 121 of the Emergency Economic Stabilization Act ("EESA") to conduct investigations and audits related to the TARP program and to report quarterly to Congress regarding TARP activity. Neil M. Barofsky, formerly an Assistant United States Attorney in the Southern District of New York, was sworn in as Special Inspector General on December 15, 2008.
On March 25, 2009, Congress unanimously passed the SIGTARP Act of 2009, which expands SIGTARP’s oversight authorities and reach, and gives it hiring flexibility and access to resources in order to staff up more quickly.
Update on TARP Programs and Use of TARP Funds
As of March 31, 2009, 47% of the $700 billion of TARP funds that had been made available as of that date had been expended. The largest allocation, 28.4% (almost $200 billion), was distributed through the Capital Purchase Program, which provided funding to Bank of America, Citigroup, JP Morgan Chase, Wells Fargo, Goldman Sachs, Morgan Stanley, and other financial institutions. $40 billion has been allocated to AIG under the Systematically Significant Failing Institutions Program. Citigroup has received $5 billion under the Asset Guarantee Program. General Motors and Chrysler have received a total of $24.8 billion under the Automotive Industry Financing Program. Finally, an additional $20 billion has been disbursed under the TALF program.
All but $109.5 billion of the $700 billion in TARP funds have been "committed", or are projected to be spent under current Treasury plans. During a hearing before the Joint Economic Committee on April 23, 2009, Rep. Linda Sanchez (D-CA) pointed out that Treasury expects approximately $25 billion in TARP funds to be returned by banks by the end of the year and asked Barofsky whether these funds could legally be re-deployed by Treasury as part of the TARP program, thus treating TARP in part like a "revolving fund." Barofsky testified that Treasury does in fact have the ability to re-use returned funds under TARP until the end of 2009.
SIGTARP’s Oversight Activities
Investigations. While the Report does not detail particular investigations that SIGTARP has initiated or undertaken, the office is clearly ramping up its investigative activity. Barofsky noted in his testimony that the first criminal charges have been filed in connection with a SIGTARP investigation – charges of mail and wire fraud against an individual attempting to sell a fictional "TARP Act securities" investment. To date, SIGTARP has received and analyzed almost 200 tips and initiated nearly twenty criminal investigations. These investigations include allegations of corporate and securities fraud, insider trading, public corruption, and mortgage-modification fraud.
SIGTARP has organized a multi-agency task force to monitor and investigate any efforts to criminally profit from the Term Asset-Backed Securities Loan Facility (TALF). The task force also includes members of:
Representatives of these organizations receive regular briefings about TALF, identify areas vulnerable to fraud, and train agents and analysts about complex program issues. Barofsky testified that the role of this task force is being expanded to cover the Public-Private Investment Program as well.
Audits. SIGTARP is currently conducting six audits, as follows:
1. SIGTARP issued a survey to the 364 companies that received TARP funds as of January 31, 2009 to determine how those funds have been used.
2. SIGTARP is examining whether TARP recipients are implementing controls addressing executive compensation restrictions.
3. SIGTARP is auditing Treasury’s decision-making regarding the first nine institutions considered for TARP funding. The audit will first examine the review and approval processes governing TARP assistance to Bank of America under three different TARP programs and the additional TARP assistance provided to Bank of America for its acquisition of Merrill Lynch.
4. SIGTARP is examining the extent to which external parties have attempted to influence the decisions of Treasury or bank regulators regarding applications for TARP funding.
5. SIGTARP is conducting a review of the federal oversight of executive compensation requirements. In particular, SIGTARP is auditing the bonus payouts to AIG employees to determine whether they were made in accordance with conditions imposed on TARP assistance. SIGTARP will also examine Treasury’s monitoring of AIG’s executive compensation agreements to determine whether Treasury was aware of the range of bonus payments.
6. In response to reports that AIG made counterparty payments to other financial institutions at 100% of face value, SIGTARP is examining the basis for these payments and determining whether efforts were made to negotiate reductions.
These audits are in varying stages of completion and will occupy a considerable amount of SIGTARP time and resources over the coming months. Nevertheless, we expect SIGTARP to aggressively open additional audits as resources permit.
TARP Restrictions on Executive Compensation
Financial institutions participating in TARP are subject to the executive compensation provisions set forth under the Emergency Economic Stabilization Act, as amended by the American Recovery and Reinvestment Act of 2009 ("AARA"). AARA imposes upon TARP recipients:
Treasury will be issuing new regulations to implement these provisions. These requirements apply as long as the institution has any obligations arising from TARP assistance. During this time, the CEO and CFO of the institution must provide written certifications of compliance to the SEC or the Treasury Secretary.
SIGTARP is focusing considerable attention on executive compensation-related oversight. In addition to the audit activity noted above, SIGTARP wrote to Treasury last month asking the agency to justify how its decision not to apply executive compensation restrictions to the TALF program is consistent with the EESA. We expect this focus to continue and that the SIGTARP will examine closely Treasury executive compensation regulations once they are issued.
SIGTARP’s Recommendations on the Operation of TARP
SIGTARP recommended in its initial report that Treasury require TARP recipients to account for their use of TARP funds, set up internal controls to comply with such accounting, and report periodically to Treasury with sworn certifications. Treasury has indicated that it will not adopt those initial recommendations. During his opening statement at the Congressional Oversight Panel hearing, Rep. Kevin Brady (R-TX) chided Treasury for its continued resistance to adopting these "common-sense safeguards."
SIGTARP’s five main recommendations in this Report are:
1. SIGTARP recommends that Treasury require TARP recipients to report on their use of TARP funds. The recommendation is intended to cover large insurance companies that may have purchased banks eligible for the Capital Purchase Program, transactions in which TARP funds are used to purchase troubled assets in the Public-Private Investment Program ("PPIP"), and surrenders of collateral in TALF.
2. To mitigate the fraud risks associated with the expansion of TALF to permit the posting of MBS as collateral, SIGTARP recommends:
a. Individual screening for legacy residential MBS,
b. Rejection of any residential MBS as collateral if the backing loans do not meet certain baseline underwriting criteria or are in categories vulnerable to fraud (e.g., certain undocumented subprime residential mortgages referred to as "liar loans"), and
c. Higher haircuts for all MBS, especially for legacy residential MBS.
3. To address aspects of PPIP which make it vulnerable to fraud – such as conflicts of interest between fund managers, collusion between participants, and vulnerability to money laundering – SIGTARP recommends that Treasury should:
a. Impose strict conflict-of-interest rules upon Public-Private Investment Fund ("PPIF") managers,
b. Mandate transparency with respect to the participation and management of PPIFs, such as disclosure of the beneficial owners of the private equity stakes and all transactions undertaken in the PPIFs,
c. Require that all PPIF managers have stringent investor-screening procedures (e.g., "Know Your Customer" requirements) similar to those of commercial banks and retail brokerage operations.
4. SIGTARP cautions against any expansion of TALF that would dilute the private party’s personal stake and incentive to conduct appropriate due diligence. In particular, SIGTARP concludes that Treasury should not allow Legacy Securities PPIFs to invest in TALF absent mitigating measures such as a prohibition on the use of leverage for PPIFs investing through TALF or an increase in haircuts for PPIFs that do.
5. To avoid fraud in the mortgage modification program, SIGTARP recommends that Treasury should:
a. Require third-party verification of residence and income,
b. Confirm the identities of participants through a closing-like procedure,
c. Delay modification incentive payments to services,
d. Educate homeowners about the program, and
e. Maintain a database of identifying information about each participant in each mortgage modification transaction.
In the four and one-half months since Special Inspector General Neil Barofsky was confirmed, SIGTARP has been extremely active in carrying out its oversight functions. These efforts, which have earned Barofsky widespread praise on Capitol Hill, are likely to increase significantly over time. While SIGTARP had a staff of 35 as of March 31, 2009, its goal is to field a team of 150 full-time employees.
SIGTARP has broad authorities to conduct, supervise, and coordinate audits and investigations into any actions taken under EESA and to undertake law enforcement functions without obtaining up front Attorney General approval. And it is using or plans to use these authorities.
SIGTARP’s activities are different than those of traditional Inspectors General in that its focus is more external, although it has the traditional Inspector General Act authorities, including the power to subpoena documents and information from private entities. It is conducting oversight and investigations of non-governmental entities and persons to a degree that is unusual in the Inspector General community. That, however, is the nature of its charge, particularly in the current political climate. Moreover, Barofsky has made clear that he will approach investigations under his authority in a prosecutorial fashion, building on his background as an AUSA.
Companies and individuals contacted by the SIGTARP should be certain to understand both the nature of the inquiry and the authorities and powers that are at its disposal.
Gibson Dunn has assembled a team of experts who are prepared to meet client needs as they arise in conjunction with the issues discussed above. Please contact Michael Bopp (202-955-8256, firstname.lastname@example.org) in the firm’s Washington, D.C. office or any of the following members of the Financial Markets Crisis Group:
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Mel Levine – Century City (310-557-8098, email@example.com)
John F. Olson – Washington, D.C. (202-955-8522, firstname.lastname@example.org)
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Alan Platt – Washington, D.C. (202- 887-3660, firstname.lastname@example.org)
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Executive and Incentive Compensation Expertise
Stephen W. Fackler – Palo Alto (650-849-5385, email@example.com)
Charles F. Feldman – New York (212-351-3908, firstname.lastname@example.org)
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© 2009 Gibson, Dunn & Crutcher LLP
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